Availability bias. Be afraid of coconuts, not sharks.
Availability bias is the tendency to consider events more likely if they are easier to recall. It can lead investors to make investment decisions based on readily available information, such as advertising or personal beliefs. Discover whether you are prone to an availability bias and the extent to which it affects your investment decisions with PRAAMS BehaviouRisk.
Behavioural science. What is availability bias?
This bias is the tendency to regard specific risk factors as more likely because they are easier to recall. For example, many people think being killed by a shark is more likely than being killed by a coconut. However, according to statistics, the latter is around 15 times more likely. Being killed by a shark is easier to recall from your memory (perhaps, thanks to a famous movie); do you know anyone who knows anyone who can relate a real story about deadly coconuts?
Availability bias is a cognitive bias, i.e., a mistake in decision-making. These biases can be effectively corrected with education.
What are the consequences and portfolio risks?
The most common root of availability bias is advertising and misselling. It is more likely that an average investor will pick a heavily advertised ETF trade idea because its name is easier to recall. Also, investment firms tend to promote their best funds heavily, thereby feeding investors the illusion that all their ETFs are that good and will meet their investment objectives. The second concerns how closely a company’s image relates to one’s beliefs and values. For example, a strong supporter of the environmental movement will regard companies that claim the ESG agenda is their top priority (not necessarily true) as a more attractive asset allocation option. Another explanation deals with an investor’s focus. An employee at a venture capital fund investing in IT companies is likelier to say that the best asset allocation strategies are in the IT sector. At the same time, an employee at a biotech-focused fund would prioritise biotech companies for investment.
What can I do to make my portfolio optimal?
So often, the easiest-to-recall answer tends to be incorrect. If you feel that you already have the answer without proper risk analysis, this may well be a sign of availability bias. It is better to check again if you notice that it has been very easy for you to select a specific investment. It could be because this investment has recently been in the news, in the financial press or in investor forums. Perhaps you work in this sphere and constantly hear about your industry’s great potential risk-return relationship. Or is it because of a specific investment firm or its products’ massive advertising trap? Once recognised, the second essential advice is to undertake more profound risk-aware research. Thoroughly conducted, numbers-driven research effectively helps overcome availability bias and many other biases.
